Chapter 11: Derivatives
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FINANCIAL DERIVATIVES SAMPLE QUESTIONS Q1. a Strangle Is an Investment Strategy That Combines A. a Call and a Put for the Same
FINANCIAL DERIVATIVES SAMPLE QUESTIONS Q1. A strangle is an investment strategy that combines a. A call and a put for the same expiry date but at different strike prices b. Two puts and one call with the same expiry date c. Two calls and one put with the same expiry dates d. A call and a put at the same strike price and expiry date Answer: a. Q2. A trader buys 2 June expiry call options each at a strike price of Rs. 200 and Rs. 220 and sells two call options with a strike price of Rs. 210, this strategy is a a. Bull Spread b. Bear call spread c. Butterfly spread d. Calendar spread Answer c. Q3. The option price will ceteris paribus be negatively related to the volatility of the cash price of the underlying. a. The statement is true b. The statement is false c. The statement is partially true d. The statement is partially false Answer: b. Q 4. A put option with a strike price of Rs. 1176 is selling at a premium of Rs. 36. What will be the price at which it will break even for the buyer of the option a. Rs. 1870 b. Rs. 1194 c. Rs. 1140 d. Rs. 1940 Answer b. Q5 A put option should always be exercised _______ if it is deep in the money a. early b. never c. at the beginning of the trading period d. at the end of the trading period Answer a. Q6. Bermudan options can only be exercised at maturity a. -
Up to EUR 3,500,000.00 7% Fixed Rate Bonds Due 6 April 2026 ISIN
Up to EUR 3,500,000.00 7% Fixed Rate Bonds due 6 April 2026 ISIN IT0005440976 Terms and Conditions Executed by EPizza S.p.A. 4126-6190-7500.7 This Terms and Conditions are dated 6 April 2021. EPizza S.p.A., a company limited by shares incorporated in Italy as a società per azioni, whose registered office is at Piazza Castello n. 19, 20123 Milan, Italy, enrolled with the companies’ register of Milan-Monza-Brianza- Lodi under No. and fiscal code No. 08950850969, VAT No. 08950850969 (the “Issuer”). *** The issue of up to EUR 3,500,000.00 (three million and five hundred thousand /00) 7% (seven per cent.) fixed rate bonds due 6 April 2026 (the “Bonds”) was authorised by the Board of Directors of the Issuer, by exercising the powers conferred to it by the Articles (as defined below), through a resolution passed on 26 March 2021. The Bonds shall be issued and held subject to and with the benefit of the provisions of this Terms and Conditions. All such provisions shall be binding on the Issuer, the Bondholders (and their successors in title) and all Persons claiming through or under them and shall endure for the benefit of the Bondholders (and their successors in title). The Bondholders (and their successors in title) are deemed to have notice of all the provisions of this Terms and Conditions and the Articles. Copies of each of the Articles and this Terms and Conditions are available for inspection during normal business hours at the registered office for the time being of the Issuer being, as at the date of this Terms and Conditions, at Piazza Castello n. -
Section 1256 and Foreign Currency Derivatives
Section 1256 and Foreign Currency Derivatives Viva Hammer1 Mark-to-market taxation was considered “a fundamental departure from the concept of income realization in the U.S. tax law”2 when it was introduced in 1981. Congress was only game to propose the concept because of rampant “straddle” shelters that were undermining the U.S. tax system and commodities derivatives markets. Early in tax history, the Supreme Court articulated the realization principle as a Constitutional limitation on Congress’ taxing power. But in 1981, lawmakers makers felt confident imposing mark-to-market on exchange traded futures contracts because of the exchanges’ system of variation margin. However, when in 1982 non-exchange foreign currency traders asked to come within the ambit of mark-to-market taxation, Congress acceded to their demands even though this market had no equivalent to variation margin. This opportunistic rather than policy-driven history has spawned a great debate amongst tax practitioners as to the scope of the mark-to-market rule governing foreign currency contracts. Several recent cases have added fuel to the debate. The Straddle Shelters of the 1970s Straddle shelters were developed to exploit several structural flaws in the U.S. tax system: (1) the vast gulf between ordinary income tax rate (maximum 70%) and long term capital gain rate (28%), (2) the arbitrary distinction between capital gain and ordinary income, making it relatively easy to convert one to the other, and (3) the non- economic tax treatment of derivative contracts. Straddle shelters were so pervasive that in 1978 it was estimated that more than 75% of the open interest in silver futures were entered into to accommodate tax straddles and demand for U.S. -
Lecture 5 an Introduction to European Put Options. Moneyness
Lecture: 5 Course: M339D/M389D - Intro to Financial Math Page: 1 of 5 University of Texas at Austin Lecture 5 An introduction to European put options. Moneyness. 5.1. Put options. A put option gives the owner the right { but not the obligation { to sell the underlying asset at a predetermined price during a predetermined time period. The seller of a put option is obligated to buy if asked. The mechanics of the European put option are the following: at time−0: (1) the contract is agreed upon between the buyer and the writer of the option, (2) the logistics of the contract are worked out (these include the underlying asset, the expiration date T and the strike price K), (3) the buyer of the option pays a premium to the writer; at time−T : the buyer of the option can choose whether he/she will sell the underlying asset for the strike price K. 5.1.1. The European put option payoff. We already went through a similar procedure with European call options, so we will just briefly repeat the mental exercise and figure out the European-put-buyer's profit. If the strike price K exceeds the final asset price S(T ), i.e., if S(T ) < K, this means that the put-option holder is able to sell the asset for a higher price than he/she would be able to in the market. In fact, in our perfectly liquid markets, he/she would be able to purchase the asset for S(T ) and immediately sell it to the put writer for the strike price K. -
Interest Rate Options
Interest Rate Options Saurav Sen April 2001 Contents 1. Caps and Floors 2 1.1. Defintions . 2 1.2. Plain Vanilla Caps . 2 1.2.1. Caplets . 3 1.2.2. Caps . 4 1.2.3. Bootstrapping the Forward Volatility Curve . 4 1.2.4. Caplet as a Put Option on a Zero-Coupon Bond . 5 1.2.5. Hedging Caps . 6 1.3. Floors . 7 1.3.1. Pricing and Hedging . 7 1.3.2. Put-Call Parity . 7 1.3.3. At-the-money (ATM) Caps and Floors . 7 1.4. Digital Caps . 8 1.4.1. Pricing . 8 1.4.2. Hedging . 8 1.5. Other Exotic Caps and Floors . 9 1.5.1. Knock-In Caps . 9 1.5.2. LIBOR Reset Caps . 9 1.5.3. Auto Caps . 9 1.5.4. Chooser Caps . 9 1.5.5. CMS Caps and Floors . 9 2. Swap Options 10 2.1. Swaps: A Brief Review of Essentials . 10 2.2. Swaptions . 11 2.2.1. Definitions . 11 2.2.2. Payoff Structure . 11 2.2.3. Pricing . 12 2.2.4. Put-Call Parity and Moneyness for Swaptions . 13 2.2.5. Hedging . 13 2.3. Constant Maturity Swaps . 13 2.3.1. Definition . 13 2.3.2. Pricing . 14 1 2.3.3. Approximate CMS Convexity Correction . 14 2.3.4. Pricing (continued) . 15 2.3.5. CMS Summary . 15 2.4. Other Swap Options . 16 2.4.1. LIBOR in Arrears Swaps . 16 2.4.2. Bermudan Swaptions . 16 2.4.3. Hybrid Structures . 17 Appendix: The Black Model 17 A.1. -
How Much Do Banks Use Credit Derivatives to Reduce Risk?
How much do banks use credit derivatives to reduce risk? Bernadette A. Minton, René Stulz, and Rohan Williamson* June 2006 This paper examines the use of credit derivatives by US bank holding companies from 1999 to 2003 with assets in excess of one billion dollars. Using the Federal Reserve Bank of Chicago Bank Holding Company Database, we find that in 2003 only 19 large banks out of 345 use credit derivatives. Though few banks use credit derivatives, the assets of these banks represent on average two thirds of the assets of bank holding companies with assets in excess of $1 billion. To the extent that banks have positions in credit derivatives, they tend to be used more for dealer activities than for hedging activities. Nevertheless, a majority of the banks that use credit derivative are net buyers of credit protection. Banks are more likely to be net protection buyers if they engage in asset securitization, originate foreign loans, and have lower capital ratios. The likelihood of a bank being a net protection buyer is positively related to the percentage of commercial and industrial loans in a bank’s loan portfolio and negatively or not related to other types of bank loans. The use of credit derivatives by banks is limited because adverse selection and moral hazard problems make the market for credit derivatives illiquid for the typical credit exposures of banks. *Respectively, Associate Professor, The Ohio State University; Everett D. Reese Chair of Banking and Monetary Economics, The Ohio State University and NBER; and Associate Professor, Georgetown University. We are grateful to Jim O’Brien and Mark Carey for discussions. -
The Synthetic Collateralised Debt Obligation: Analysing the Super-Senior Swap Element
The Synthetic Collateralised Debt Obligation: analysing the Super-Senior Swap element Nicoletta Baldini * July 2003 Basic Facts In a typical cash flow securitization a SPV (Special Purpose Vehicle) transfers interest income and principal repayments from a portfolio of risky assets, the so called asset pool, to a prioritized set of tranches. The level of credit exposure of every single tranche depends upon its level of subordination: so, the junior tranche will be the first to bear the effect of a credit deterioration of the asset pool, and senior tranches the last. The asset pool can be made up by either any type of debt instrument, mainly bonds or bank loans, or Credit Default Swaps (CDS) in which the SPV sells protection1. When the asset pool is made up solely of CDS contracts we talk of ‘synthetic’ Collateralized Debt Obligations (CDOs); in the so called ‘semi-synthetic’ CDOs, instead, the asset pool is made up by both debt instruments and CDS contracts. The tranches backed by the asset pool can be funded or not, depending upon the fact that the final investor purchases a true debt instrument (note) or a mere synthetic credit exposure. Generally, when the asset pool is constituted by debt instruments, the SPV issues notes (usually divided in more tranches) which are sold to the final investor; in synthetic CDOs, instead, tranches are represented by basket CDSs with which the final investor sells protection to the SPV. In any case all the tranches can be interpreted as percentile basket credit derivatives and their degree of subordination determines the percentiles of the asset pool loss distribution concerning them It is not unusual to find both funded and unfunded tranches within the same securitisation: this is the case for synthetic CDOs (but the same could occur with semi-synthetic CDOs) in which notes are issued and the raised cash is invested in risk free bonds that serve as collateral. -
Finance: a Quantitative Introduction Chapter 9 Real Options Analysis
Investment opportunities as options The option to defer More real options Some extensions Finance: A Quantitative Introduction Chapter 9 Real Options Analysis Nico van der Wijst 1 Finance: A Quantitative Introduction c Cambridge University Press Investment opportunities as options The option to defer More real options Some extensions 1 Investment opportunities as options 2 The option to defer 3 More real options 4 Some extensions 2 Finance: A Quantitative Introduction c Cambridge University Press Investment opportunities as options Option analogy The option to defer Sources of option value More real options Limitations of option analogy Some extensions The essential economic characteristic of options is: the flexibility to exercise or not possibility to choose best alternative walk away from bad outcomes Stocks and bonds are passively held, no flexibility Investments in real assets also have flexibility, projects can be: delayed or speeded up made bigger or smaller abandoned early or extended beyond original life-time, etc. 3 Finance: A Quantitative Introduction c Cambridge University Press Investment opportunities as options Option analogy The option to defer Sources of option value More real options Limitations of option analogy Some extensions Real Options Analysis Studies and values this flexibility Real options are options where underlying value is a real asset not a financial asset as stock, bond, currency Flexibility in real investments means: changing cash flows along the way: profiting from opportunities, cutting off losses Discounted -
Buying Options on Futures Contracts. a Guide to Uses
NATIONAL FUTURES ASSOCIATION Buying Options on Futures Contracts A Guide to Uses and Risks Table of Contents 4 Introduction 6 Part One: The Vocabulary of Options Trading 10 Part Two: The Arithmetic of Option Premiums 10 Intrinsic Value 10 Time Value 12 Part Three: The Mechanics of Buying and Writing Options 12 Commission Charges 13 Leverage 13 The First Step: Calculate the Break-Even Price 15 Factors Affecting the Choice of an Option 18 After You Buy an Option: What Then? 21 Who Writes Options and Why 22 Risk Caution 23 Part Four: A Pre-Investment Checklist 25 NFA Information and Resources Buying Options on Futures Contracts: A Guide to Uses and Risks National Futures Association is a Congressionally authorized self- regulatory organization of the United States futures industry. Its mission is to provide innovative regulatory pro- grams and services that ensure futures industry integrity, protect market par- ticipants and help NFA Members meet their regulatory responsibilities. This booklet has been prepared as a part of NFA’s continuing public educa- tion efforts to provide information about the futures industry to potential investors. Disclaimer: This brochure only discusses the most common type of commodity options traded in the U.S.—options on futures contracts traded on a regulated exchange and exercisable at any time before they expire. If you are considering trading options on the underlying commodity itself or options that can only be exercised at or near their expiration date, ask your broker for more information. 3 Introduction Although futures contracts have been traded on U.S. exchanges since 1865, options on futures contracts were not introduced until 1982. -
Implied Volatility Modeling
Implied Volatility Modeling Sarves Verma, Gunhan Mehmet Ertosun, Wei Wang, Benjamin Ambruster, Kay Giesecke I Introduction Although Black-Scholes formula is very popular among market practitioners, when applied to call and put options, it often reduces to a means of quoting options in terms of another parameter, the implied volatility. Further, the function σ BS TK ),(: ⎯⎯→ σ BS TK ),( t t ………………………………(1) is called the implied volatility surface. Two significant features of the surface is worth mentioning”: a) the non-flat profile of the surface which is often called the ‘smile’or the ‘skew’ suggests that the Black-Scholes formula is inefficient to price options b) the level of implied volatilities changes with time thus deforming it continuously. Since, the black- scholes model fails to model volatility, modeling implied volatility has become an active area of research. At present, volatility is modeled in primarily four different ways which are : a) The stochastic volatility model which assumes a stochastic nature of volatility [1]. The problem with this approach often lies in finding the market price of volatility risk which can’t be observed in the market. b) The deterministic volatility function (DVF) which assumes that volatility is a function of time alone and is completely deterministic [2,3]. This fails because as mentioned before the implied volatility surface changes with time continuously and is unpredictable at a given point of time. Ergo, the lattice model [2] & the Dupire approach [3] often fail[4] c) a factor based approach which assumes that implied volatility can be constructed by forming basis vectors. Further, one can use implied volatility as a mean reverting Ornstein-Ulhenbeck process for estimating implied volatility[5]. -
307439 Ferdig Master Thesis
Master's Thesis Using Derivatives And Structured Products To Enhance Investment Performance In A Low-Yielding Environment - COPENHAGEN BUSINESS SCHOOL - MSc Finance And Investments Maria Gjelsvik Berg P˚al-AndreasIversen Supervisor: Søren Plesner Date Of Submission: 28.04.2017 Characters (Ink. Space): 189.349 Pages: 114 ABSTRACT This paper provides an investigation of retail investors' possibility to enhance their investment performance in a low-yielding environment by using derivatives. The current low-yielding financial market makes safe investments in traditional vehicles, such as money market funds and safe bonds, close to zero- or even negative-yielding. Some retail investors are therefore in need of alternative investment vehicles that can enhance their performance. By conducting Monte Carlo simulations and difference in mean testing, we test for enhancement in performance for investors using option strategies, relative to investors investing in the S&P 500 index. This paper contributes to previous papers by emphasizing the downside risk and asymmetry in return distributions to a larger extent. We find several option strategies to outperform the benchmark, implying that performance enhancement is achievable by trading derivatives. The result is however strongly dependent on the investors' ability to choose the right option strategy, both in terms of correctly anticipated market movements and the net premium received or paid to enter the strategy. 1 Contents Chapter 1 - Introduction4 Problem Statement................................6 Methodology...................................7 Limitations....................................7 Literature Review.................................8 Structure..................................... 12 Chapter 2 - Theory 14 Low-Yielding Environment............................ 14 How Are People Affected By A Low-Yield Environment?........ 16 Low-Yield Environment's Impact On The Stock Market........ -
Tax Treatment of Derivatives
United States Viva Hammer* Tax Treatment of Derivatives 1. Introduction instruments, as well as principles of general applicability. Often, the nature of the derivative instrument will dictate The US federal income taxation of derivative instruments whether it is taxed as a capital asset or an ordinary asset is determined under numerous tax rules set forth in the US (see discussion of section 1256 contracts, below). In other tax code, the regulations thereunder (and supplemented instances, the nature of the taxpayer will dictate whether it by various forms of published and unpublished guidance is taxed as a capital asset or an ordinary asset (see discus- from the US tax authorities and by the case law).1 These tax sion of dealers versus traders, below). rules dictate the US federal income taxation of derivative instruments without regard to applicable accounting rules. Generally, the starting point will be to determine whether the instrument is a “capital asset” or an “ordinary asset” The tax rules applicable to derivative instruments have in the hands of the taxpayer. Section 1221 defines “capital developed over time in piecemeal fashion. There are no assets” by exclusion – unless an asset falls within one of general principles governing the taxation of derivatives eight enumerated exceptions, it is viewed as a capital asset. in the United States. Every transaction must be examined Exceptions to capital asset treatment relevant to taxpayers in light of these piecemeal rules. Key considerations for transacting in derivative instruments include the excep- issuers and holders of derivative instruments under US tions for (1) hedging transactions3 and (2) “commodities tax principles will include the character of income, gain, derivative financial instruments” held by a “commodities loss and deduction related to the instrument (ordinary derivatives dealer”.4 vs.